Investment in Alternative Assets: Split Decisions

Senior executives were surveyed from 450 large hedge funds and institutions, revealing 3 perspectives on portfolio management and alternative investing trends. Part 3.

The last few years have been interesting times indeed for institutional investors. Many, such as insurance companies, have faced increased regulation with higher capital adequacy ratios, and all have grappled with lower returns from more traditional investments as the low interest rate environment has persisted at a time of slow global growth.

Public markets have been subject to violent swings and oil prices have risen sharply only to fall back again to levels last seen a decade ago. Generating returns in such an environment is challenging and requires investors to consider three main avenues for achieving good outcomes for their portfolios. First, using leverage to magnify returns; second, identifying (and getting comfortable with) increasing concentration in specific sectors or investment styles; and third, moving down the liquidity spectrum to consider investments with long time horizons.

The various investments that make up the alternative investment landscape offer opportunities for some or all of these three return-boosting strategies, and that helps explain why alternatives are gaining ground in institutional portfolios, often at the expense of more traditional asset classes.

As our study shows, appetite for alternatives is set to rise further over the coming years. This is the result of strong returns generated by alternative strategies, both on an absolute and relative basis. However, our study also demonstrates that, despite the increasing flows of capital to alternative assets, fund managers have to adapt and innovate to attract a share of this. Investors may be keen on alternatives, but they are increasingly discerning about where and how they deploy their capital. Importantly, they are also acutely aware of the erosive effect of fees on their returns, which is exerting pressure on the traditional 2 and 20 model that alternative investment fund managers have become accustomed to.

These trends are leading to wide-ranging changes in the alternatives space, from the development of new products and structures such as managed and separate accounts, liquid alternatives in the hedge fund space and the rise of co-investments in private equity. We are also seeing a bifurcation between larger players that are seeking to offer investors a range of alternative strategies under one roof and those that are carving out a niche for themselves to specialize in a particular area or strategy.

The upshot, for investors, is an increasing array of choices in what was once a small corner of the investment landscape and is steadily becoming an integral part of the institutional portfolio. The alternative investment asset class is maturing – and it’s maturing fast.

Key Findings

Private equity is the most popular alternative investment strategy, accounting for 37% of investors’ alternative exposure, followed by infrastructure and real estate, both just under 25%. Private equity is also set for the most growth, with 53% of investors saying they will increase their allocation over the next 12 months.

Alternative investments have generated strong returns for investors, with 93% saying they had met or exceeded expectations over the last 12 months. Private equity appears to have outperformed its alternative peers, with 97% saying returns had met or exceeded expectations. »» Overall, the majority of respondents (65%) said that alternatives had returned at least 12%, with over a quarter (28%) reporting performance of 15% or more. Hedge funds have generated the most exceptional returns, with over a tenth (12%) of respondents saying net historical returns had been 18% or more.

Emerging markets now make up 31% of institutions’ alternative investment exposure, although further growth looks limited – investors are planning to allocate 34% of alternative investment to emerging markets.

Fees are firmly in investors’ sights, with 62% saying they will look for lower private equity fees in the next 12 months and 63% saying the same about hedge funds. Transparency and performance are also hot buttons for investors in both types of alternative, with around half saying they will focus on these areas when investing over the next 12 months.

In private equity, secondaries investments look set for growth, with 77% of investors seeking to increase their sales in the secondaries market and 63% looking to buy more commitments via secondaries.

In hedge funds, distressed strategies top the list of most attractive in the current and future environment: 68% of investors currently have exposure to this strategy and 57% rank it as one of the three most attractive strategies over the next 12 months.

Chapter 1: The Asset Allocation Landscape

As alternative asset classes rise up the allocation agenda, we investigate the current climate and look to the future.

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